Phil Bolton for GlobalAtlanta
The most recent U.S. Treasury Department global capital movement figures show that in April the U.S. experienced a $13.3 billion shortfall of capital flowing into the country as opposed to its trade deficit for the month, according to Omer Esiner, a market analyst in the Washington headquarters of Ruesch International Inc.

Mr. Esiner told GlobalAtlanta in a telephone interview last week that the last time that the U.S. experienced a similar shortfall was in December 2005, and that while the April shortfall provided “an area of concern” for the stability of the U.S. dollar, it should not be overly dramatized.

The U.S. Treasury reported on June 15 that the April capital inflows reached $46.7 billion, while the trade deficit for the month was $60 billion.

“This does provide an area of concern for the stability of the U.S. dollar because of the massive structural current account deficit. The U.S. must constantly attract foreign capital to pay for its trade deficit,” Mr. Esiner told GlobalAtlanta in a telephone interview last week.

He also cited the March figures, which are more representative of the monthly figures for the past year, as showing capital inflows of $69.8 billion and a trade deficit for the month of $61.8 billion.

Ruesch International is a provider of international payment services that is owned by the private equity firm Welsh, Carson, Anderson & Stowe. A sponsor of GlobalAtlanta, Ruesch International provides our readers with periodic updates on foreign exchange rates.

The Treasury International Capital (TIC) reporting system is responsible for the collection and maintenance of information on international capital movements and investment positions, excluding direct investment.

While Mr. Esiner expressed some concern about the April figures, the firm’s senior market analyst, Alex Beuzelin, did not foresee a dramatic change in the capital inflows when interviewed by GlobalAtlanta on June 14.

The portion of Mr. Beuzelin’s interview dealing with the stability of the U.S. dollar follows:

GlobalAtlanta: What do you think are the prospects for foreign direct investment in the United States given the declining value of the dollar?

Ruesch: That, of course, touches at the heart of one of the main risks that the U.S. currency faces — as America’s current account deficit grows, and continues to be financed largely by investments from overseas. Will foreign investors continue to put their money in the U.S., or will they become rattled by the fact that the current account deficit is nearing 7 percent of gross domestic product as the dollar weakens?

There you have before you the main risk that the U.S. currency faces. Up to now, the latest net capital flows data that we have form the Treasury Department’s so-called TIC data shows that foreign investor appetite for U.S. assets has not waned significantly and continues to comfortably finance the current account deficit.

So every month that we see this, where foreign investment more than offsets America’s spending spree, there is a bit of relief for the market and protection to the U.S. dollar. But you can’t deny the risk because of the sheer magnitude of the current account deficit. Typically under the old economic model, if your current account deficit approaches 5 percent of GDP, then that places a significant amount of risk on your currency. We’re at about 6.7 percent now. So that puts the U.S. current account deficit beyond that 5 percent redline.

But because the U.S. dollar is the world’s reserve currency, it has by itself the type of selling pressure that other currencies might expect to see when you have a current account deficit of this size. Going forward that remains a key risk for the dollar.

At this point, I don’t see foreign investors significantly shying away from the U.S. financial markets because at the end of the day, the U.S. economy is the world’s largest economy. It is the most flexible economy, the most transparent and liquid financial market and that’s going to continue to be prized by investors.

In fact, if you look at the behavior of the financial markets over the last couple of months, we’ve seen renewed concerns about inflation risks. This has sparked some pretty dramatic sell offs in global equities, in emerging markets and commodities. The favored destination of investors seeking liquidity and seeking safety has been U.S. treasuries.

So I think that the U.S. will continue to be a destination of choice for foreign investors, and I don’t see that appeal being significantly eroded even if the dollar continues to weaken. In fact, at some point, U.S. assets become more appealing to foreigners because a weaker dollar will obviously make it a lot less expensive for them to go ahead and place investments here in the United States, both in their portfolios and directly.

GlobalAtlanta: How do you feel about the TIC figures. Do you feel that their accuracy is pretty good? And how do they compile that information?

Ruesch: I think that the accuracy of the information is certainly not in question. It’s a number that the financial markets place emphasis on and look at in a credible fashion. There is no issue with the TIC data. The data measures foreign investor purchases of U.S. equities, Treasury bonds, corporate bonds, agency bonds and also U.S. investment or U.S. purchases of foreign assets.

GlobalAtlanta: Have you noticed central banks diversifying away from the U.S. dollar in their foreign exchange reserve holdings?

Ruesch: This is an issue that I think is going to continue to pose a risk to the U.S. dollar, but what we’re talking about here is not global central banks abandoning the dollar and stocking up on euros and Japanese yen and British pounds, but rather maybe rebalancing their portfolios where the dollar is still going to maintain its preeminent position in their foreign exchange reserves.

But because there is such a significant current account deficit in the U.S., even a little bit of pulling back in terms of dollar accumulation by global central banks is enough to spook the markets.

That concern could gain more traction if China were to proceed more decisively towards currency reevaluation, towards exchange rate flexibility, because as the Chinese allow their exchange rate to be more market driven, more market determined, there may be less of a need for it to keep accumulating U.S. dollar reserves to maintain their current exchange rate system.

As China allows more flexibility over time, it enables other Asian export dependent economies to allow their currencies to trade more freely without having to be worried about any negative competitive ramifications on their export sectors.

GlobalAtlanta: Are you concerned about the risks to the U.S. economy because of the amount of consumer debt?

Ruesch: By all accounts the levels certainly are elevated, but given the strength of the economy they seem to be manageable. I think that the key risk involves the high energy prices that are driving up interest rates. Consumers are being squeezed. The cost of debt servicing is becoming more expensive. The bottom line is that the elevated levels of consumer debt are going to become more expensive and may serve to curtail consumer spending, which, of course, is the lion’s share of our economy.

So I think that in the current environment, with these elevated energy prices, with interest rates continuing to rise, with debt servicing becoming more expensive, there is a risk to household spending and it is likely to be one of the factors that contributes to the U.S. economy slowing, moderating the rate of growth as we proceed through 2006.

GlobalAtlanta: The economy is still growing pretty well, is it not?

Ruesch: Absolutely. First quarter actually was revised up to 5.3 percent on an annualized basis. Market forecasts say the U.S. economy’s pace of growth is to moderate towards the 3-3.5 percent over the final three months of this year. That seems to be in line with what the Fed is projecting as well.

GlobalAtlanta: Are you concerned about inflation in this environment, or do you think that these other factors will dampen it?

Ruesch: That’s another very topical issue at this point in time. Over the last few weeks, inflation fears have come to the fore very assertively and have knocked Wall Street down sharply as well as the global markets, the emerging marketing and the commodities markets.

A key catalyst has been Fed Chairman Ben Bernanke, who surprised the market with his assessment that inflation pressures are now at an “unwelcome level.” So the Fed has over the past weeks been consistently beating the drumbeat of inflation risk. This has sparked concerns that interest rates will need to go significantly higher.

If we look at the actual data itself, I think on balance it shows that core inflation remains contained. But, certainly, the risks seem to be augmenting. Over the last few weeks, the personal expenditure price index moved above 2 percent, which is considered as kind of the top end of the comfort zone for consumption expenditure inflation. The Fed pays particularly close attention to this core index.

Just yesterday, June 13, we saw the core producer price index, on a monthly basis, come in above expectations with the annual core consumer price index reaching its highest level since last year. So I think that there is concern that the pace of inflation is picking up. Expectations are rising that price pressures could become more of a problem and that that is going to necessitate higher interest rates.

I guess essentially the overall level of inflation still remains under control and contained, but there does seem to be some evidence to suggest that those risks may be increasing because of high energy prices and because the slower economy may not be sufficient enough, at least in the near term, to put a damper on those price risks.

GlobalAtlanta: What is the possibility of the dollar further dropping? How do you think that would affect the global economy overall?

Ruesch: The U.S. dollar, despite its bounce-back in recent weeks, is still seen trending lower as we proceed through 2006. At this point, the anticipation is that the U.S. currency will continue to decline.

But that is going to take the Fed one step closer to putting an end too its rate tightening cycle and that should be happening at some point during the third quarter of this year.

Once the Fed is done raising interest rates, the U.S. interest rate differentials, the U.S. interest rate premium will cease to improve against major currency counterparts, like the euro, the Canadian dollar, the Japanese yen, and the British pound. Topping out of the U.S. interest rate tightening cycle will usher in the second key risk for the dollar and that is the structural deficit we talked about earlier.

If you go back to the period between 2002-04, that was a three-year dollar bear market, largely founded on concerns about America’s structural deficit. In 2005, we saw the dollar generally strengthen, with the exception being against the Canadian dollar among the majors and that was because the Federal Reserve was raising interest rates. For that one year, 2005, you had these so-called cyclical factors outweighing the dollar’s structural liabilities.

GlobalAtlanta: How does that affect the global economy overall?

Ruesch: The weaker dollar, in terms of the U.S. economy, can be a positive, at least as far as growth is concerned because a weaker dollar can stimulate U.S. exports, make U.S. products more competitive or less expensive for foreign countries and that can help over time to reduce the trade deficit. So a weaker dollar can be stimulating for U.S. economic growth, but if dollar depreciation is significant, if it is dramatic, this can have adverse consequences for global growth because that means that countries in Asia, Japan and Europe, which depend so much on sending their exports to the U.S., will have much tougher times in terms of their economies.

GlobalAtlanta: Is the dollar at this point pretty much on an even keel?

Ruesch: I think that as long as dollar depreciation is orderly, the global economy can manage the slide. When you are talking about the macroeconomic impact, a lot has to do with the degree of depreciation, the pace of depreciation and the scale of depreciation. As long as the markets are orderly and adjustments are made in a fashion that is not disruptive, then I think that the global economy can digest a environment with a weaker U.S. currency.

GlobalAtlanta: How important is improving the trade balance for the U.S. in terms of the overall structural and risk concerns on the deficit as a whole?

Ruesch: Anytime that we have an improvement in the trade numbers that seems to provide relief for market concerns about those deficits. Over the last few months we’ve seen some stabilization in the U.S. trade deficit, but I think that this is not going to be turning on a dime. The trade deficit still faces further risks because of the fact that the U.S. economy continues to significantly outpace its major trading counterparts. That means we are probably going to continue to buy more stuff from them than they sell to us.

And that will put pressure on the trade deficit. Also, with oil prices still elevated near nominal record highs, that is something that is going to keep the oil import bill relatively expensive and also something that will continue to keep pressure on the trade deficit.

But the bright spot is that if the dollar does manage to depreciate in an orderly fashion that will help to run around the trade imbalance over time.

In addition, if we continue to see tentative signs of stronger growth in Europe, and stronger growth in Japan is sustained, then those developments would help to reverse the current account deficit and to minimize or mitigate those risks.
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